Green finance 101: How to mobilize funds for the planet

The ins and outs of sustainable investing

Luxembourg City, a global hub for green finance and host city of GLF Luxembourg. dr. zaro, Flickr
31 October 2019

This topic will be discussed at the Global Landscapes Forum Luxembourg on 30 November.

Restoring our planet’s landscapes is one of the most important ways to combat climate change – and ambitious restoration targets have already been set at the international level. The Bonn Challenge aims to bring 150 million hectares globally under restoration by 2020 and a further 200 million hectares by 2030.

Yet funding has been a major obstacle. Although forests and agriculture make up over 30 percent of the solution to climate change, they receive less than 3 percent of climate financing. The U.N. and other development agencies hope to redouble efforts to raise funds for restoration when the Decade on Ecosystem Restoration kicks off in 2021. But who are the key players in the rapidly-growing field of green finance, and how are they working together to mobilize funds for restoration, climate and other green investments?

Here, Landscape News brings you a brief (and by no means exhaustive) overview of the green finance landscape, including its many definitions, key concepts, processes and main actors, as well as a glossary of key terms.

What is green finance?

“Green finance” is a broad term with multiple definitions and is used interchangeably with “sustainable finance” and “climate finance” depending on context. Here are a few attempts to define it:

  • The European Union: “The provision of finance to investments taking into account environmental, social and governance considerations”
  • The Convention for Biological Diversity (CBD) describes green finance as comprising the following:
    • “The financing of public and private green investments” in both “environmental goods and services,”
    • “The financing of public policies that encourage the implementation of environmental and environmental-damage mitigation or adaptation projects and initiatives,” and
    • “Components of the financial system that deal specifically with green investments.”
  • United Nations Framework Convention on Climate Change (UNFCCC): “Local, national or transnational financing – drawn from public, private and alternative sources of financing – that seeks to support mitigation and adaptation actions that will address climate change”

For a more detailed definition, consider that of the Global Sustainable Investment Alliance (GSIA), which “uses an inclusive definition of sustainable investing, without drawing distinctions between this and related terms such as responsible investing and socially responsible investing.” The GSIA maintains seven ways of screening investments:

  • Negative/exclusionary screening: excludes certain sectors based on environmental/social governance (ESG) criteria (e.g. fossil fuels, weapons, tobacco)
  • Positive/best-in-class screening: selects specific sectors based on positive ESG performance
  • Norms-based screening: investments must meet minimum standards of business practice based on international norms (e.g. UN, OECD, ILO)
  • ESG integration: explicit inclusion of ESG factors into financial analysis
  • Sustainability-themed investing: “investment in themes or assets specifically related to sustainability” (e.g. clean energy, green technology, sustainable agriculture)
  • Impact/community investing: “targeted investments aimed at solving social or environmental problems, including community investing”
  • Corporate engagement and shareholder action: “use of shareholder power to influence corporate behavior”

Who are the key providers of green finance?

Sources: Black to Green Consulting and DIE/GDI

Corporations are the largest source of climate-related funding, both through CSR initiatives and their investments in multiple sectors including renewable energy, transportation and infrastructure.

Banks provide a significant proportion of the financial resources that can be mobilized for green investments.

International financial institutions can support the scaling-up of green investments by testing new ways of financing, channeling funds toward sustainable development through mechanisms such as green bonds, and influencing global financial governance to give more support to sustainable development. These include green investment banks and development banks, which provide funding for sustainability- and development-related projects respectively.

International organizations such as the U.N., the OECD and the G20 only provide limited finance but set the agenda on sustainability issues at the international level and help coordinate sources of funding.

Climate funds, such as the Green Climate Fund, Adaptation Fund, Global Environment Facility and Climate Investment Funds, are multilateral funds for climate change adaptation and mitigation projects, funded through contributions from individual countries.

National governments determine the amount of public funding earmarked for green investments, as well as institutional support for them. They can also support the design of dedicated domestic investment vehicles such as national climate and environmental funds.

Central banks and regulatory authorities can also steer the finance sector toward green investments through policies and regulations.

Institutional investors, such as pension funds, sovereign wealth funds and insurers, are another important group of private-sector financiers.

Stock exchanges also often specialize in green and sustainable investments. For example, the Luxembourg Green Exchange (LGX), attached to the Luxembourg Stock Exchange, operates as a dedicated platform for green, social and sustainable securities.

How does green finance attract investors and catalyze private investment?

Source: GEF

The two main financial instruments in green finance are equity and debt.

  • In the early stages of a project, equity financing is the main investment method used, and investors receive an ownership interest (stocks or shares) in the project in return for the amount of capital they invest.
  • In later stages of a project, debt financing becomes the predominant investment method. Investors lend money to borrowers, and this money is repaid with interest.

Debt financing can take two forms: loans and bonds. A loan is a transfer of money from a bank to a company or individual, whereas a bond is a transfer of money from the public or market to a company that issues the bond. Bonds typically involve large sums (USD 100 million and above) and can be bought by the general public.

Green investment projects and their backers engage in a practice known as leveraging – reducing the perceived risk of a project in order to encourage private investors to back it. Leveraging strategies include using loan and credit guarantees and investing in junior equity or subordinated debt.

Guarantees: Investors often manage risk using loan or credit guarantees from public finance institutions. This transfers the risk of the investment from the investor onto the institution, which serves as a loan guarantor. Given the lower risk to the investor, the lender can then pay a lower interest rate on the loan, reducing its capital costs and increasing profitability.

Junior equity: There are two types of stock: common stock (also called junior equity) and preferred stock. In the event of liquidation, holders of preferred stock must be paid out before those of common stock, therefore are exposed to lower risk. To attract other potential equity investors, climate funds and impact investors invest specifically in common stock to absorb some of the risk for other investors who purchase preferred stock.

Subordinated debt: In investments that do not involve equity, climate funds and impact investors can take the most junior debt position in a company to ensure that they are paid last in the event of liquidation. Like investing in junior equity, this also absorbs some of the risks for other investors.

How are funds being raised to support restoration?

There is a small but growing network of impact funds supporting forest and landscape restoration (FLR), and the social impact platform GatherLab lists over 50 such funds globally focusing on regenerative agriculture and forestry.

At the international level, the Food and Agriculture Organization (FAO) and the U.N. Convention to Combat Desertification (UNCCD) have identified several work streams that policymakers can unleash to mobilize resources to support FLR:

  • Mainstream FLR in state budgets: funds can be earmarked for restoration initiatives, kept in check through public expenditure reviews, and FLR can be integrated into national accounting. In the field of development aid, donor countries can also provide funds specifically to support FLR.
  • Set up appropriate funding mechanisms: these can include national environmental or forest funds or public incentive schemes (such as payments for ecosystem services), as well as support for local approaches.
  • Engage the private sector: policymakers can work with companies to promote voluntary commitments through corporate social responsibility (CSR) schemes. They can attract investors by developing marketplaces for FLR, reducing the risks of FLR investments (e.g. through backing them with public institutions), or gathering data on FLR costs and benefits. Policymakers can also attract investors indirectly by supporting private impact investment funds and layered funds.
  • Build alliances and partnerships: these can be built at the international, regional, national or local level, ranging from global partnerships like the Bonn Challenge and New York Declaration on Forests to working with NGOs, small businesses and farmers at the local level.

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